Buying the Right Sell-Off Stocks

CNBC.com

Tuesday, 7 Aug 2012 | 6:42 PM ETCNBC.com

SHARES

There are two specific kinds of stocks "Mad Money" host Jim Cramer looks for during a sell-off: those knocked from their highs and those that pay dividends. The more brutal the sell-off, he said, the more attractive these stocks tend to look.

The new-high list is always a great place to look for investments. After all, stocks usually don’t make it there for no reason, Cramer said. But a stock that’s hit a new high can be expensive, turning off interested traders.

A correction takes care of that dilemma, though. If a market dip is the only reason the share price has dropped, chances are the stock is solid. So those are exactly the kinds of companies Cramer suggests you look for because they tend to rebound the fastest when the market turns up.

The caveat here is that not all stocks pushed off the new-high list are worth buying. In fact, often times they’re the companies leading the sell-off. Investors have to do their homework to figure out which stocks are worth owning and which aren't.

Cramer also searches for dividend-paying stocks during a correction. When the market declines, and with it the share prices of these stocks, yields go up. (Remember: A $1 dividend on a $20 stock has a 5 percent yield. The yield on a $10 stock with a $1 dividend is 10 percent.) And while dividends aren’t sexy, he admitted, they put money in your pocket during the hard times of a sell-off.

This, of course, is based on the notion that a company has no intention of cutting its dividend. That’s why you never buy a damaged company just because the yield has skyrocketed. Damaged companies might cut their dividends. Companies with damaged stocks probably won’t. Cramer’s rule of thumb: If the company’s expected earnings are twice the size of the dividend payment, then the dividend should be reasonably safe.

A sell-off is an opportunity to buy, Cramer said, especially stocks that have just pulled off their highs, and stocks with dividends that have grown larger thanks to the decline.